Friday Financial Foul Ups: How Financial Knowledge Can Hurt

This week’s Friday Financial Foul Up will feature a submission from Shawanda of You Have More Than You Think. Shawanda is one of our fellow DC Bloggers and was one of the first bloggers I met in person. I really respect her opinions and her writing. Shawanda is a CPA (so she really does have finance experience) and practices extreme frugality (not as cool as extreme sports!). If you want more of Shawanda you can follow her on twitter (@theycallmecheap). Enjoy her foul up of KNOWING what to do and NOT following through on that knowledge!

My first personal finance book was The Wall Street Journal Guide to Planning Your Financial Future. It was given to me as a high school graduation gift by one of my closest friends. I’ve been smitten with the subject matter ever since.

Now, I’m no expert, but I do know a thing or two about money. As we all know, and so easily forget, knowing is only half the battle.

The Situation

When I began my professional career in August 2004, I was far more well equipped with financial wealth building information than your average 22 year old. I knew the value in diversification, passive income, tax deferment, and, most important, compound interest.

In order to comfortably retire, I figured I should invest at least 12% of my annual income. I didn’t arrive at that percentage as a result of some complicated, scientific calculation. David Bach, in his book Smart Women Finish Rich, said it was a good idea so I went with it.

When it comes to retirement planning, you won’t get very far in Money Management 101 without learning the hierarchy of proper cash allocation.

Invest in your 401(k) up to the maximum your employer will match. At the time, the company I worked for offered a pitiful 25% match on up to 6% of my salary. Although measly, it’s 3 times more than a reasonable return on a balanced portfolio.

If you qualify, max out a Roth IRA. You fund a Roth IRA with after-tax dollars so you don’t have to worry about paying inflated tax rates later when you’re, you know, rich. In 2010, the most you can contribute to an IRA is $5,000 if you’re under 50 years old and $6,000 if you’re 50 or older.

Max out your 401(k).Although there is such a thing as a Roth 401(k), many companies only offer the traditional version which is still good. Funding one adds tax diversification to your portfolio. Plus, you can contribute up to $16,500 in 2010 to a 401(k) if you’re under 50 years old and up to $22,000 if you’re 50 or older.

If at any point during this three step process I hit 12% of my annual income, I stop investing.

That’s great stuff, right?

Where I Fouled Up

I knew exactly what to do. So, here’s what I did:

I invested 6% of my salary in my 401(k). Remember that’s the most my employer matched.

I didn’t save an additional dime and spent the money I should’ve invested in a Roth IRA on clothes, shoes, eating out, and other foolishness for two straight years.

Once the extra cash landed in my paycheck, all that financial prowess went out the window. Besides laziness and lack of self control, I really can’t think of any other reasons I only contributed 50% of what I originally planned to my retirement accounts. I know opening an IRA is really easy. It’s still fresh in my memory, because I just opened my first Roth IRA last month, in January 2010.

If I knew then what I know now, I would’ve contributed the entire 12% to my 401(k). Maybe it’s not the best strategy, but it sure beats the one I implemented.

What I Learned

Even as a child, I understood the differences between knowing, saying, and doing. All that information didn’t stop me from sitting on my butt and not doingwhat I knew I should’ve done.

At this point in my financial journey, I don’t even attempt to do what will yield me the greatest overall return. I simply focus on what I’m likely to do.

Recently, I realized I probably won’t get around to doing the proper research required to create an optimal investment portfolio anytime soon. Instead, I set aside a chunk of money and immediately invested it in low expense, commission-free, ETFs (Exchange Traded Funds) from Charles Schwab.

“At this point in my financial journey, I don’t even attempt to do what will yield me the greatest overall return. I simply focus on what I’m likely to do.”

Best advice ever. It’s self-knowledge and working with what you’ve got rather than pretending to be some paragon of financial virtue when you’re not. Kudos for the insight.

Like you, I saved a lot less in my early years than I should have, but injecting realism about who you are and what actions you are likely to take are way better than trying to become some theoretical actor in a financial model.

You can study economics and finances all you want. What are you actually going to do is the question, right? (There are a lot of ppl making lots of money who are stupidly overleveraged out there.)

Hi Shawanda, thanks for your post. Just to clarify, are you considering your 401K contributions as part of your 12% goal? If so, do you believe that your 401K and ROTH are enough to retire on when you retire?

My approach is a little different, but wanted to hear your thoughts first.

Also, any insight on how hard it is (passing rate) and how long it takes to study for the CPA? Thnx!

Shawanda – I won’t even discuss my foul-ups here. At 35, I’ve just started to get with the program. I have an appointment to open my IRA next week. Ridiculous. Suffice it to say that I’ll be bookmark this after my appt and get it together. Thanks for this great post. This information is invaluable.

@mapgirl – It was a video of a TED talk called The Paradox of Choice by Dr. Barry Schultz that got me to realize how access to information and freedom of choice could really hold me back financially. I’d highly recommend it.

@Financial Samurai – I currently invest 15% of my gross income in retirement accounts which includes my 401(k). My overall savings rate is closer to 40% – 45%. Currently, I don’t need to add any more money to my emergency fund so the additional 25% – 30% will go into long-term investments outside of retirement accounts. I’ll figure out what to do with that money later. Assuming life goes well and I continue to live below my means, 15% should be enough to retire on.

There was a time when you had to take the four part exam over 2 days. Now, you have an 18 month window to pass all four sections. I’m sure this makes it easier. I wouldn’t say it’s a terribly difficult exam, but I also studied…a lot. I also know people who sat for it seven times and took over three years to pass all four sections.

@Tiffany Thompson – Thanks. At least you’re still young. There are people facing retirement and still haven’t gotten their stuff together. Many of them will either live off the government or their loved ones. Both options are just sad.

I’d also like to add the last ten years yielded some of the worst U.S. stock market returns since reliable record keeping began. Therefore, it should be easier to catch up to where you would’ve been had you started investing when you were 25.

I so love this post. I’m one of those people that believe personal finance is “personal” it’s hard to follow one person advice. Everyone situation is so unique. I started saving 6% of my income, now I am at 15% next will be 25%.

hello!,I really like your writing very much! percentage we communicate more about your article on AOL? I require a specialist in this space to solve my problem. Maybe that is you! Taking a look ahead to see you. |

Friday Financial Foul Ups: How Financial Knowledge Can Hurt

This week’s Friday Financial Foul Up will feature a submission from Shawanda of You Have More Than You Think. Shawanda is one of our fellow DC Bloggers and was one of the first bloggers I met in person. I really respect her opinions and her writing. Shawanda is a CPA (so she really does have finance experience) and practices extreme frugality (not as cool as extreme sports!). If you want more of Shawanda you can follow her on twitter (@theycallmecheap). Enjoy her foul up of KNOWING what to do and NOT following through on that knowledge!

My first personal finance book was The Wall Street Journal Guide to Planning Your Financial Future. It was given to me as a high school graduation gift by one of my closest friends. I’ve been smitten with the subject matter ever since.

Now, I’m no expert, but I do know a thing or two about money. As we all know, and so easily forget, knowing is only half the battle.

The Situation

When I began my professional career in August 2004, I was far more well equipped with financial wealth building information than your average 22 year old. I knew the value in diversification, passive income, tax deferment, and, most important, compound interest.

In order to comfortably retire, I figured I should invest at least 12% of my annual income. I didn’t arrive at that percentage as a result of some complicated, scientific calculation. David Bach, in his book Smart Women Finish Rich, said it was a good idea so I went with it.

When it comes to retirement planning, you won’t get very far in Money Management 101 without learning the hierarchy of proper cash allocation.

Invest in your 401(k) up to the maximum your employer will match. At the time, the company I worked for offered a pitiful 25% match on up to 6% of my salary. Although measly, it’s 3 times more than a reasonable return on a balanced portfolio.

If you qualify, max out a Roth IRA. You fund a Roth IRA with after-tax dollars so you don’t have to worry about paying inflated tax rates later when you’re, you know, rich. In 2010, the most you can contribute to an IRA is $5,000 if you’re under 50 years old and $6,000 if you’re 50 or older.

Max out your 401(k).Although there is such a thing as a Roth 401(k), many companies only offer the traditional version which is still good. Funding one adds tax diversification to your portfolio. Plus, you can contribute up to $16,500 in 2010 to a 401(k) if you’re under 50 years old and up to $22,000 if you’re 50 or older.

If at any point during this three step process I hit 12% of my annual income, I stop investing.

That’s great stuff, right?

Where I Fouled Up

I knew exactly what to do. So, here’s what I did:

I invested 6% of my salary in my 401(k). Remember that’s the most my employer matched.

I didn’t save an additional dime and spent the money I should’ve invested in a Roth IRA on clothes, shoes, eating out, and other foolishness for two straight years.

Once the extra cash landed in my paycheck, all that financial prowess went out the window. Besides laziness and lack of self control, I really can’t think of any other reasons I only contributed 50% of what I originally planned to my retirement accounts. I know opening an IRA is really easy. It’s still fresh in my memory, because I just opened my first Roth IRA last month, in January 2010.

If I knew then what I know now, I would’ve contributed the entire 12% to my 401(k). Maybe it’s not the best strategy, but it sure beats the one I implemented.

What I Learned

Even as a child, I understood the differences between knowing, saying, and doing. All that information didn’t stop me from sitting on my butt and not doingwhat I knew I should’ve done.

At this point in my financial journey, I don’t even attempt to do what will yield me the greatest overall return. I simply focus on what I’m likely to do.

Recently, I realized I probably won’t get around to doing the proper research required to create an optimal investment portfolio anytime soon. Instead, I set aside a chunk of money and immediately invested it in low expense, commission-free, ETFs (Exchange Traded Funds) from Charles Schwab.

“At this point in my financial journey, I don’t even attempt to do what will yield me the greatest overall return. I simply focus on what I’m likely to do.”

Best advice ever. It’s self-knowledge and working with what you’ve got rather than pretending to be some paragon of financial virtue when you’re not. Kudos for the insight.

Like you, I saved a lot less in my early years than I should have, but injecting realism about who you are and what actions you are likely to take are way better than trying to become some theoretical actor in a financial model.

You can study economics and finances all you want. What are you actually going to do is the question, right? (There are a lot of ppl making lots of money who are stupidly overleveraged out there.)

Hi Shawanda, thanks for your post. Just to clarify, are you considering your 401K contributions as part of your 12% goal? If so, do you believe that your 401K and ROTH are enough to retire on when you retire?

My approach is a little different, but wanted to hear your thoughts first.

Also, any insight on how hard it is (passing rate) and how long it takes to study for the CPA? Thnx!

Shawanda – I won’t even discuss my foul-ups here. At 35, I’ve just started to get with the program. I have an appointment to open my IRA next week. Ridiculous. Suffice it to say that I’ll be bookmark this after my appt and get it together. Thanks for this great post. This information is invaluable.

@mapgirl – It was a video of a TED talk called The Paradox of Choice by Dr. Barry Schultz that got me to realize how access to information and freedom of choice could really hold me back financially. I’d highly recommend it.

@Financial Samurai – I currently invest 15% of my gross income in retirement accounts which includes my 401(k). My overall savings rate is closer to 40% – 45%. Currently, I don’t need to add any more money to my emergency fund so the additional 25% – 30% will go into long-term investments outside of retirement accounts. I’ll figure out what to do with that money later. Assuming life goes well and I continue to live below my means, 15% should be enough to retire on.

There was a time when you had to take the four part exam over 2 days. Now, you have an 18 month window to pass all four sections. I’m sure this makes it easier. I wouldn’t say it’s a terribly difficult exam, but I also studied…a lot. I also know people who sat for it seven times and took over three years to pass all four sections.

@Tiffany Thompson – Thanks. At least you’re still young. There are people facing retirement and still haven’t gotten their stuff together. Many of them will either live off the government or their loved ones. Both options are just sad.

I’d also like to add the last ten years yielded some of the worst U.S. stock market returns since reliable record keeping began. Therefore, it should be easier to catch up to where you would’ve been had you started investing when you were 25.

I so love this post. I’m one of those people that believe personal finance is “personal” it’s hard to follow one person advice. Everyone situation is so unique. I started saving 6% of my income, now I am at 15% next will be 25%.

hello!,I really like your writing very much! percentage we communicate more about your article on AOL? I require a specialist in this space to solve my problem. Maybe that is you! Taking a look ahead to see you. |